Dollar Bulls have come out from hiding in the last week on a relief rally that has the Federal Reserve to thank. While discussing the likelihood of Balance Sheet run-off in 2017, the Federal Reserve also said that another rate hike was expected this year followed by three more in 2018. Currently, when looking at Fed Funds futures contracts, the probability is weighted to a hold in September with announcements on Balance Sheet run-off, which is presumed to be USD-positive, and a rate hike in December if warranted by a turnaround in the data. If we had to label the conversations from recent Fed Presidents following the announced rate hike, I would apply the term, very cautious optimism. The Fed does have the benefit of hiking during the easiest money conditions per the Federal Reserve Bank of Chicago Financial Conditions Index since 2014, which is before they began hiking. However, the Citi Economic Surprise Index for the US Economy is rebounding from the weakest levels in six years. Economic surprise indices are subject to wildly optimistic or pessimistic expectations from economists, but they are telling none the less.

Another development in the market worth watching that likely has implications for the Fed, and the Dollar is the flattening US yield curve. Recently, the US5/30 Yield Curve where one would sell the 5-year UST and buy the 30-year UST had seen the spread reduce or flatten to the lowest level since December 2007, when the US Economy was entering into a recession that would eventually lead to the credit crisis of 2008.

Traders should note that as the yield curve flattens, it tends to mark speculative excesses and not the immediate pain that typically arises from yield curve inversion that many associate with recession. While the curve obviously needs to flatten before it can invert, to try to get in front of the trade, could lead to a painful outcome.

EURUSD: Retail trader data shows 30.9% of traders are net-long with the ratio of traders short to long at 2.24 to 1. In fact, traders have remained net-short since Apr 18 when EURUSD traded near 1.05975; price has moved 5.3% higher since then. The number of traders net-long is 1.4% lower than yesterday and 7.1% lower from last week, while the number of traders net-short is 2.2% lower than yesterday and 3.4% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EURUSD prices may continue to rise. Positioning is less net-short than yesterday but more net-short from last week. The combination of current sentiment and recent changes gives us a further mixed EURUSD trading bias. (Emphasis mine)